New Legislation Introduced to Allow Discharge of Private Student Debt

The Consumer Financial Protection Bureau (the “CFPB”) reported in 2012 that U.S. borrowers are burdened by more than $1 trillion in student debt, including over $150 billion of private student loans.1 According to TransUnion, a credit bureau, the average student debt each borrower carries rose 30% in the past 5 years and more than half of student loan accounts are in deferral status. During the same 5 year time span, FICO Labs, a unit of Fair Isaac Corp., which publishes consumer credit scores, found that delinquencies increased by 22%.3 In an attempt to defuse the next potential “debt bomb,” Sens. Dick Durbin (D-Ill.), Sheldon Whitehouse (D-R.I.) and Jack Reed (D-Ill.) co-sponsored the Fairness for Struggling Students Act (“S. 114”) in the Senate, and Congressmen Steve Cohen (D-Tenn.) and Danny Davis (D-Ill) introduced the Private Student Loan Bankruptcy Fairness Act (“HR 532” and collectively with S. 114, the “Bills”) in the House.

Currently, all student loans are non-dischargeable, meaning that they cannot be discharged in bankruptcy absent a showing of undue hardship. Showing undue hardship is difficult, so most student loans are effectively non-dischargeable. Federal student loans have been non-dischargeable since 1976. Private student loans became non-dischargeable pursuant to the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the “BAPCPA”).4 The Bills would reverse certain portions of BAPCPA to allow borrowers to discharge their private student loans in bankruptcy. Federal student loans, though, would continue to be non-dischargeable.

Consumer advocates argue that private student loans should be treated differently than federal student loans for bankruptcy purposes.5 The advocates say that requiring a showing of undue hardship is reasonable before discharging a federal loan because discharging a federal loan would result in a loss to taxpayers. Federal loans also have several built-in protections, including caps on interest rates, flexible repayments options, and postponement or reduction of monthly payments during times of hardship. On the other hand, private student loans often have higher interest rates and do not allow deferment or income-based repayments. According to Congressman Davis, “private education debt is no different than other consumer debt; it involves private profit and deserves no privileged treatment.”6 By treating private student loans similarly to credit card debt, Sen. Reed hopes that the legislation will “send an important message to lenders and students that they need to be responsible.”7

On the other hand, lenders warn that allowing discharge of student loans would increase the cost for all student borrowers.8 The lenders say that allowing borrowers to discharge their private student loans would increase interest rates and decrease the available funds for new loans because of higher risks to lenders. Furthermore, because federal loans are capped to only cover tuition and certain approved fees, students may nevertheless have no choice but to obtain private loans at the higher interest rates to cover the gaps. The end result would merely increase the total cost of education for many borrowers. In any event, the Bills appear to offer only an incomplete solution to the problem because private student loans account for less than 80% of total student loans in the U.S. Many individuals argue that the root cause of the student debt problem is actually rising tuition costs, so allowing borrowers to discharge their private student loans would accomplish nothing more than creating “a one-time, unjust transfer from innocent lenders who did nothing more than give money to people in the hopes of being repaid someday.”9

The Bills would also impact lenders who securitize their private student loan portfolios. Rating agencies look to several collateral characteristics when rating a pool of student loans for securitization, including:

school type (e.g., graduate vs. undergraduate vs. vocational),

co-signature status (i.e. whether or not there is a creditworthy co-signer on the loan),

credit score,

repayment option (e.g., immediate vs. deferred), and

origination channel (e.g., directly to student or through schools).10

The primary risk in private student loan securitizations, though, is credit risk because private student loans are not guaranteed by the U.S. Department of Education. Instead, private student loans are underwritten like traditional unsecured consumer loans by focusing on the credit history of the borrower. Recovery rates are currently higher for private student loans than other unsecured consumer loans because, as opposed to typical consumer debt, e.g. credit cards, that can be dischargeable in bankruptcy, private student loans are non-dischargeable. The Bills, by providing borrowers the ability to discharge their private student loans, could increase the credit risk for private student loan securitizations, which would impact a securitization’s yield, rating, and collateralization requirements, among others.

The Bills are currently in their respective committees, but it is unclear whether the Bills will be passed. The CFPB’s report has generated more popular support on the issue than in the past. S. 114 has received seven co-sponsors, HR 532 has received 14 co-sponsors, and Sallie Mae, the largest private student lender, “supports reform that would allow federal and private student loans to be dischargeable in bankruptcy for those who have made a good-faith effort to repay their student loans over a five-to-seven year period and still experience financial difficulty.”11 On the other hand, Senator Durbin authored similar pieces of legislation in at least three previous sessions of Congress. Legislation similar to the HR 532 has also been introduced at least five times in the House. None of those bills were successful.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.

- hide

Privacy Policy (Updated: October 8, 2015):

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.